I was thinking about some of the problems of fractional reserve banking. The way that the money supply can blow up and shrink again by such a large factor causes all sorts of problems that I know you Austrians are very familiar with. Part of the problem is that when a bank lends money, and that money gets spent then the money comes back to the bank and can be used as reserves to be lent out again (well 90% anyway). It occurred to me that a very simple system could be used to ensure that money only ever gets lent out once once once only. Simply have two types of money, one type that can be lent out and another which cant. Both of which have equal value. Lets call them red money and green money for convenience. Just have one rule in the system as follows: If someone wants to borrow money from a bank, the bank is only allowed to give them red money, all other aspects of the system could operate as before. The maximum amount of lending that can be done is then controlled by the ratio of red to green money.
So my questions are:
Would it work? i.e. would it produce an economic system less prone to ABCT problems?
when you say “let them”, you mean have government control this system using force?
If there is one thing we should learn from history, its when governments control and/or manipulate money, they ruin it.
There should be no “let them”…how about giving us the freedom to use whatever we want as money…let people be free to decide whatever they want, let business be free to use whatever we want.
I think it would work. I’m not particularly well versed in money and banking, though…
As for it being thought of before, I’ve certainly never heard of it…
Mildly changing subject here, one simple thing that could be done is to increase the reserve requirement by a lot. For instance, Suriname has the highest modern-day reserve requirement (that I know of) at 35%. Hong Kong’s is 18% and China’s is 15.5%, and both countries (is it fair to call Hong Kong it’s own country?) not surprisingly have much higher savings rates. Turkey in 1968 had a reserve requirement of 62.7%. Now I realize that’s not perfect, but I think it’d be a step in the right direction.
Well for one thing, they are a nuisance for the customer to maintain, having to constantly juggle money between the accounts and having to make a guess at how long they can do without spending their money. And secondly I’m not sure that it prevents the inflating/deflating of the money supply.. does it? - is there an article on mises.org which extols the benefits of time deposits? I had thought that time deposits were more about preventing bank runs than preventing changes in the money supply, but I’m not certain of that, so I will happily be corrected.
A time deposit should really be called a loan to the bank. Assuming you call it a time deposit, the depositor would have to know that he could not access the money for x amount of time. A demand deposit is supposed to keep full availability of the money in the deposit to the depositor and thus should never be used by a bank for loans. As long as the system does not allow 2 or more people to have a claim to and exchange the same pile of money, the system won’t be inflationary or deflationary.
After a while, the red money would drop in value compared to the green money, because people would want money they can redeposit in a bank. After all, why settle for money that limits your options?
By Gresham’s law, all the green money would disappear. We would have only red money circulating. Is this what we want? Money that cannot be deposited in a bank? Sure, banks are bad, but they do have SOME function, I presume.
Another thing is, how much of the problem would having red money solve? Fractional reserve banking can do plenty of harm even with red money existing. The fact that for every dollar a bank has it can lend 10 dollars is plenty bad right there. The mises movie about the Fed shows how its really 100 times or more, through some complication the Fed introduces that I dont remember.
A1: I don’t think it would make any difference if banks made their ‘cash reserve ratio’ the same as their required reserves. The ratio of loans to deposits would still be the same. Maybe a bit more of the deposits would be held as cash.
I’m not sure of the figures, but if you look at your central bank’s money supply aggregates, you would find M0 - notes and coins - would be a small percentage of the broad money supply anyway. Somewhere around 2-5%.
Time deposits ensure that only one person to a sum of money at the same time. But it doesn’t prevent multiple people having claim to a single sum of money. So I believe it does inflate the monetary base just like FRB.
In my proposed system any kind of money can be deposited in a bank. But only red money can be loaned.
But guess that would mean that banks may only be willing to pay interest on red money… which I concede could be a problem. Let me think that one over and I’ll see if I can come up with a work-around. Good point.
I don’t think so. Banks lending out some money is fine by me. How else could anyone borrow to invest ever?
The whole point of my red/green system is that it puts a very clear ceiling on the money multiplier that would be very easy to control. The government would have the power to change the red green ratio ether by modifying the composition of money that it gets through its hands and/or selecting the color of new money it prints.
In my system the monetary base could be composed of either cash (notes and coins) or electronic money - but of course the electronic money can be labeled as red or green. i.e. there is some “red” electronic money and there is some “green” electronic money. Actually, if the notes and coins fraction of the total money supply was very small (say <3%) then it wouldn’t be very important to distinguish between rad and green notes. They could perhaps all be red, and you could restrict the red/green distinction purely to cheques and electronic forms of money.
If someone had a mix of red/and green money in their bank account then when they write a cheque or use a debit card then the system could ensure that red money was transferred before green.
As long as both parties cannot access one pile of money at the same time, there shouldn’t be inflation. If I put my money in a time deposit and I will have access to it in 3 months plus interest, for those 3 months the bank is free to do with that money as it pleases (most likely in some investment) so long as it pays it back plus interest. During those 3 months, I have no claim to that money and thus cannot use it or write checks against it. I’m not entirely sure how a time deposit works, but if it simply means a loan to the bank, then that’s how it would work. Anything else would make it some sort of hybrid between a demand deposit and a loan which seems inconsistent and unnecessary in my opinion
Say I have $1000 cash I put in my bank account and I tell my bank I won’t need it for three months. The bank can then loan it out (or 90% of it depending on the rules and regulations) the next day. The borrower can then spend it via a cheque. Whoever receives that cheque is then free to say to the bank “I’ll leave this in my account for three months”. The bank is then free to lend this or 90% of it out the next day… etc. etc. It appears to be inflationary just like FRB.
I have a solution. You can ensure that the proportion of red vs green money that arrives back at the banks each day gets equalized. Say that on a particular day 30% of the money that gets deposited at banks is red. But this did not happen evenly across individual banks, one bank may have got 80% red while another got 10% red etc. You could have a system whereby the amount of read and green got switched between banks such the proportions became equalized. That way the banks would have no incentive to encourage any particular color of money to be deposited. Problem solved.
How is that a problem, the money came back to the system? Couple a fixed reserve ratio with fixed total reserves and monetary expansion doesn’t happen.
Sorry I never answered this before. But yes, increasing our reserve requirement would be a step in the right direction. But I still prefer my red/green system because the amount of lending that goes on in the economy becomes so clear and so controllable.
With a fixed reserve ratio and fixed total reserves, the total money supply will still become much larger than the monetary base as people borrow. And if a period comes where people are less keen to borrow and there is more “paying back loans” than “taking out new loans” then the money supply can shrink. Both the expansion phase and the contraction phase can happen without the government printing or removing any money. Its purely a consequence of how FRB works.
Either I am mis-understanding what you are trying to say, or you are misunderstanding how FRB works.
When you say “fixed total reserves” do you mean a fixed “monetary base”? Or something different? How do you prevent the borrowed money coming back to the banks and adding to the reserves (as happens in normal FRB)?